The problem with economics -- ideology over science

I was struck by the following video from Prof. Greg Mankiw's blog.  Prof. Mankiw links to the following video by Prof. Stephen Marglin who discusses his alternative introductory economics course.

What I noticed within the first few minutes of the talk was the way Prof. Marglin treats economics.  Economics is not about describing how economies work.  Instead, economics appears to be about promoting ideology.  Prof Marglin describes his course as first outlining traditional (market based) economics, then providing critiques and alternative economic theories.  His real concern appears to be political results -- income redistribution, environmental concerns, "justice", etc.

Economics has long attempted to become a "science".  But to be a "science", economics must focus on how economies react to various events by trying to explain past events in the economy, then moving to predicting future events.  Introductory chemistry classes describe and explain chemical reactions.  They don't discuss which chemical reactions are good or bad.  Economics, and in particular Prof. Marglin's economics, focuses not on how economies reaction to actions but instead on the desired results.

I'm afraid I would suggest that Prof. Marglin might be more at home in a political science department.  To the extent his view exists predominates (and I got the Marxist professor for one semester of introductory economics back when I was in college) perhaps the economics department should be merged with political science.

Did the government cause the Financial Crisis?

A recent blog post by Cato Institute Senior Fellow Dan Mitchell describes a recent article by Peter Wallison, a member of the Financial Crisis Inquiry Commission (FCIC) as "superb".  In this article Mr. Wallison repeats his frequent claim that government affordable housing goals caused the financial crisis by forcing banks to lower mortgage standards.

What disturbs me most about articles of this sort is that they harm the cause of private enterprise.  By trying to excuse private failings while creating a government problem, they look like they are in the pay of big business (as the left has claimed, sorry I don't have a reference handy). Free market solutions are thus discredited as help for big business rather than being evaluated on their merits.  It is better to admit when markets fail and look at why they fail (and I mention a couple reasons near the end of this piece which can be laid at the government's doorstep).

Having read the full FCIC report, including Peter Wallson's dissent, along with other research into the financial crisis, I've become tired of reading Mr. Wallison's repeated claims of government culpability.  He's been giving essentially the same argument for the last two years regardless of the actual evidence, and even regardless of his own numbers.  In no way would I term any of his articles on this subject "superb" in terms of a factual analysis, though they are "superb" for those would would blindly take the view "government is always wrong and the private sector is flawless".

What follows is a critique of Mr. Wallison's FCIC dissent, followed by a few of my own comments on government culpability in the financial crisis.

Peter Wallison's FCIC dissent is a very one sided treatment of the crisis, excusing every possible flaw in the financial industry while magnifying every government flaw.  The short form of Mr. Wallison’s one sided treatment can be seen where he discounts “Failures in Risk Management” as a cause for the crisis, terming these a “hindsight narrative” (FCIC dissent, p. 446).  Yet blaming the government for relaxed lending standards, which at the time were not seen as risky and were adopted for purely private mortgage lending, is apparently not a “hindsight narrative”.  It appears that the government, which Mr. Wallison would most likely characterize as not qualified to set lending standards, is expected to have better foresight into the consequences of its actions than “expert” bankers, who are blameless for using subprime loans as collateral for AAA bonds.

Mr. Wallison’s selective reading of history is apparent in his repeated claim that there has been no significant deregulation of the banking industry in the last 30 years, instead stating that regulation has increased (FCIC dissent p. 445-6).  This must depend on one’s definition of regulation, I’d consider the removal of interest rate caps, forced elimination of branch banking restrictions, removing the separation of commercial and investment banking, and prohibitions on the regulation of new risky financial products traded in opaque markets to be deregulation.  I would hope that nobody denies that the financial industry of 2008 was (and still is) much different from the industry 30 years earlier.

In his latest article, Mr. Wallison again brings out Edward Pinto’s analysis of the mortgage market, claiming that the FCIC ignored this data showing government (HUD) caused the crisis by lowering lending standards.  Yet the FCIC report does discuss Mr. Pinto’s analysis (p. 219), and explains why it was not considered a valid analysis.  Mr Pinto’s analysis uses a very broad definition of “subprime” and “alt-A” mortgages, classifying many more loans in these categories than others.  Using the numbers from the Pinto analysis which Mr. Wallison presents in his own FCIC dissent it is clear why this analysis is not valid.  These figures show that the bulk of bad mortgages, both by percentage and absolute numbers, were in privately financed mortgages, not those backed by Fannie, Freddie, or government agencies like HUD.  From the FCIC dissent, Table 3 on p. 462, about 3.9 million out of 10.2 million private nonprime mortgages (38%) were delinquent as opposed to 2.4 million out of 15.5 million GSE nonprime loans (15%).  By comparison prime loan default rates were under 5%.  Thus, it appears there’s a significant difference between the GSE loans which only Mr. Pinto considers subprime and private market nonprime loans (which everybody considers subprime).

Using mortgage industry delinquency numbers (Mortgage Bankers Association 2Q 2009 delinquency report), two factors identify bad loans.  The first is subprime loans (using the MBA’s narrower definition of subprime, not Mr. Pinto’s very broad definition) and the second is adjustable rate mortgages.  Oddly, loans which are directly part of government housing policy (e.g. FHA) had relatively low default rates.  If government mandated lower lending standards caused the crisis, one would expect government held loans such as FHA loans to have the highest default rates.  From this and other data I conclude that the biggest failure in mortgage underwriting was in purely private loans, not those acquired by the government.

There is still the claim that government housing policy somehow forced these lower lending standards on the private sector and thus caused the bulk of bad mortgages.  There has certainly been pressure to increase low income mortgage lending, and at least modifying (some would say lowering) standards, both from HUD and from Community Reinvestment Act (CRA) agreements.  Yet two factors argue against this as a cause for the bulk of bad loans.

1. According to Mr. Wallison's own numbers, about 30% of the GSE (Fannie and Freddie) backed loans were affordable before the new goals (and reduced lending standards) began.  The GSE goals were around 50% affordable loans.  Thus GSEs only had to add 20% more affordable loans.  While banks had CRA agreements they needed to meet, most of these loans could be sold to the GSEs. It is not clear how this extra 20% or so of affordable loans could "force" Mr. Wallison's claim that 50% of all loans were subprime.
2. Mr. Wallison equates "subprime" or "alt-A" with "affordable housing loan".  Not in a specific statement, but it is quite clear throughout his dissent that in his view subprime mortgages only exist in large numbers to meet government goals.  This goes against the evidence that large numbers of these loans were for high end properties.  While apparently being forced to lower lending standards for affordable housing goals, banks also lowered standards for high end loans.  If these "subprime" loans were so risky, why did the banks make them?  If banks didn't think they were risky (as Mr. Wallison claims) then why was it so bad for the government to promote them?
3. Lending standards have dropped across the board.  Commercial real estate loans, home equity loans, automobile loans and credit cards are all much more easily obtained today than 30 years ago, yet I’m not aware of government programs or quotas which forced banks to reduce their lending standards in these areas.  Personally, I averaged roughly one credit card offer per day in the mail in early 2008 and close to that number of mortgage refinance offers.  It was easy to maintain an overall credit card limit of over 2 times annual income and still have banks knocking down the door to lend even more.  I expected a credit crisis, though in credit cards rather than mortgages.  It was clear banks were not interested in safe, quality lending but instead encouraged high levels of consumer indebtedness.

Mr. Wallison also claims that past housing bubbles, such as 1979 and 1989, did not result in a financial crisis.  This is quite true, yet the financial markets were much different during those earlier housing bubbles.  Mr. Wallison dismisses any role for securitization in the crisis by stating that securitization has been used for decades to finance lending (FCIC dissent, p. 447).  This may be true, but as far as I know it is only in the last 10 years or so that multi-tranche loan pools have become common.  CDOs are a relatively recent invention, as are credit default swaps (CDSs) and other more complex derivatives.  Giving a AAA rating to 90% or so of the value of a pool of subprime mortgages (see the FCIC report’s sample mortgage pool) also only became common in the last few years.

It is true that the financial crisis was triggered by problems in the mortgage market, yet the reason it was so serious (shutting down the full banking system overnight) could not have been due to a few bonds defaulting or getting lower ratings.  Rather, it was the amplifying effect of relatively new financial products which caused the system to collapse like a house of cards.  This presents the dilemma of unregulated banking today.  While people and businesses might sometimes lose money, that wasn’t the problem in Sept. 2008.  The problem was that most if not all of the major sources of credit dried up, leaving businesses having nothing to do with housing on the brink of collapse.  The philosophical issue is how to deal with the collateral damage when extremely large players in the economy get into trouble.

I would argue:

1. The Financial Crisis could not have happened in 1980 or even 1990, even if mortgage standards were lowered to the pre-crisis levels.  Mortgage debt was either kept by banks (which had to account for the risk), sold to GSEs (which had higher standards), or had to be securitized as traditional bonds, which would have garnered relatively low ratings.
2. The Financial Crisis was inevitable.  The industry was packaging many forms of consumer debt into high yielding AAA rated bonds.  The lower rated portions were being repackaged as CDOs with a high percentage of AAA ratings.  But the fact is that consumer debt is not as safe as government or high quality corporate debt.  ANY credit reversal would have triggered a similar crisis.  That it was mortgages reflected the higher dollar total of mortgage debt and spiraling housing prices.

This is not to say that government doesn’t share in the blame.  Some areas include:

Mark to Market:  From what I’ve read, Mark to Market rules left firms open to wide swings in the price of mortgage backed securities and other bonds.  Many of these securities being thinly traded outside public exchanges, their values were largely a matter of opinion and guesswork.  While, from what I understand, Mark to Market was adopted to prevent firms from valuing worthless assets or liabilities at face value on their books for extended periods of time, the downside of Mark to Market is to leave firms open to day to day panic swings in markets, when prices reflect immediate fear rather than an honest market value.

Bank Capital Rules:  AAA rated mortgage backed securities were given preferred treatment as capital over other AAA securities.  This increased the demand for AAA mortgage backed securities and made banks highly susceptible to ratings downgrades.

The Bear Stearns, Fannie, and Freddie bailouts:  Up until the Lehman Brothers bankruptcy the government had not allowed any big firms to fail.  The Lehman failure led in rapid order to the financial system shutting down in fear of the next failure.  We could likely have gone through a much smaller crisis if Bear Stearns had not been propped up in early 2008.  Alternately the TARP bailouts, etc. might have been smaller if the government had supported Lehman, reducing or avoiding the immediate panic.

Thus, looking at the facts, I can’t see the logic in blaming government housing policy for the Financial Crisis.  As with the failure of any complex system, there are numerous factors involved in the crisis.  And as with failures of other complex systems, the way in which the various factors combined to cause the collapse of the financial markets was unexpected and difficult if not impossible to foresee.  Mortgages may have triggered the crisis, but many other factors had to be in place to cause the disaster which resulted.

What next?

Now that President Obama released his birth certificate, what will happen next with the "birthers" and Donald Trump?

1. The birthers will say "we were wrong" and go away?
2. They will claim it's a forgery (as they have with the previously disclosed short form)?
3. They will move on to different claims such as that he's still not a real American (having spent part of his childhood in Indonesia), his school records haven't been released, Arabs paid for his college education, etc?
4. Create a new conspiracy over why he didn't do this three years ago?

Personally, I'm guessing #1 will not be the response.

Tax fairness pledge or scam?

Recently there have been new reports of a group of wealthy individuals who sent a letter advocating that the Bush tax cuts be allowed to lapse (at least for the wealthy), saying they should pay their fair share.  There is also a group called United for a Fair Economy (http://www.faireconomy.org/) advocating higher taxes on the rich, and promoting a "tax fairness pledge".

People who take the "tax fairness pledge" say they support higher taxes. They also figure out how much more they would have paid without the Bush tax cuts. These people are encouraged to "give back" this extra money.

One might think that the logical thing to do is send the extra money to the government. This would make a statement by paying the "fair" amount of tax. But that's not what United for a Fair Economy says to do.

Instead, United for a Fair Economy suggests that the "Bush tax cut" money be given to charities, in particular United for a Fair Economy or other groups lobbying for higher taxes. So rather than giving the government its fair share, this seems a thinly disguised fundraising technique.

Those individuals who seriously feel they should pay higher taxes can already do so today. There are several way to give money to the federal government, thus paying the higher "fair" tax.

Advocating that tax savings be given to a charity is not the same as advocating fair taxation. If the purpose is to pay more taxes, then the money should go to the government, not to a charity. After all, we don't get to choose where the current tax money goes, so should not be able to choose how tax cut savings are used.

So those who want higher tax rates should put their money where their mouth is. Starting with President Obama (whose income is much higher than $250,000 per year), they should give their tax cut to the government, and provide this information publicly. If the majority of the wealthy donate their tax cut savings, this will provide a powerful statement in favor of higher taxes. On the other hand, politicians who vote for higher taxes while taking advantage of tax savings they oppose are hypocritical. They should set an example for the rest of us.

Note: I don't make over $250,000 per year, so don't have a direct interest in repealing the taxes for higher income. I do save money from the Bush tax cuts, as does my son (making near minimum wage last year), and as did my retired father-in-law living on under $20,000 per year (repealing the cuts will affect everybody who pays income tax, not just the rich).

Califormia's Proposition 8 ruling

Looking at the recent Proposition 8 decision in California (ruling against the gay marriage ban), I think the most disturbing thing about the case has nothing to do with the decision.

This was a standard court case challenging a law. The plaintiffs sue the government, but because the government can't be sued directly (sovereign immunity), they instead sue state officials, in this case the governor, attorney general, and a few others. In a normal case, the government then defends the case in court.

However, in the case of Proposition 8 this didn't happen. All of the government officials named said they didn't like Proposition 8 and would not defend against the lawsuit. The groups which pushed Proposition 8 on the ballot had to be added to the case so there would be somebody to argue both sides.

This is a disturbing precedent. It's the job of California's state officials to defend the California constitution. By failing to defend a legally enacted amendment, they are stating that they will only enforce laws they agree with.

This is a dangerous precedent. You might cheer those who didn't defend Proposition 8, but next time it may be a law you support that a politician decides to ignore.

It's the job of government officials to enforce and defend legally enacted laws. What would gay rights activists say if next California governor opposes gay marriage and decides to ignore the court ruling making it legal?

Officials must defend and enforce the law regardless of their personal feelings.

"No man is killed for any reason more than in the name of God"?

"No man is killed for any reason more than in the name of God".

I saw this quote in a blog recently and starting thinking. This is often brought out as a criticism of religion, implying that religions are somehow violent and intolerant by nature rather than peaceful. But how true is it?

A quick look through history says that there is truth to this statement. A lot of people have been killed in the name of God. And before the 20th century this statement would likely be true, especially if one discounts disease under the heading of "killed" (counting disease, the plagues of the Middle Ages were easily more deadly than any sort of religious killing).

In the 20th Century religion has a reprieve. While there have been religious conflicts (the Arab-Israeli conflict, Northern Ireland, the breakup of Yugoslavia, etc) the biggest killers were communism (Stalin, Mao, Pol Pot) and National Socialism (Hitler), both political ideologies. Other major killers are national / tribal conflicts which have killed millions in the Congo, Rwanda, Sri Lanka, and other nations. In the 20th Century religious conflict is dwarfed by these other conflicts.

Looking before the 20th century, there was certainly a lot of killing in the name of God, though some of it might be qualified. Much is made today of Islam as a violent religion, especially after the Sept. 11 attacks. However, while Muslims have engaged in wars of conquest, they have generally not engaged in a lot of bloodshed. There was little "convert or die" in the Muslim expansion of the 7th and 8th centuries. Rather, Islam was given a privileged position and people naturally converted to the official religion. Even conflicts which might be considered explicitly religious (such as the Mahdi in Sudan in the latter 1800's) were likely more a response to colonialism. In fact, much "religious" conflict might be more properly judged to be political revolt which uses religion as a rallying point.

So certainly religion has been the reason for much killing. However, it must always be remembered that religion is often an excuse for a war rather than religion causing the war. And even when a conflict is overtly religious, it is likely that the underlying causes are economic, tribal, or national differences which are encompassed in religion.

Destroying Shirley Sherrod or how conservatives shoot themselves in the foot

Andrew Breitbart has just confirmed all of the left wing critiques of conservative criticism of the Obama administration and the Democratic Congress. In the blog entry at http://biggovernment.com/abreitbart/2010/07/19/video-proof-the-naacp-awards-racism2010/ he posted a couple short clips from a speech by Shirley Sherrod, an Agriculture Department employee to the NAACP. In these clips Ms Sherrod comes out as a black racist.

The internet and conservative media (e.g. Bill O'Reilly and Sean Hannity of Fox News) jumped on the story, demanding Ms. Sherrod's resignation, though she has already resigned by the time their shows aired. The NAACP was left accused of racism and trying to do damage control.

Since then a video of Ms Sherrod's full speech has been posted (http://www.youtube.com/watch?v=E9NcCa_KjXk). The full video shows not a black racist, but somebody who has learned the world isn't just about race. After coming out, Ms Sherrod has received apologies, a new job offer, and an apology from Bill O'Reilly (who should have done his homework, as he says in the apology).

By taking Ms Sherrod's comments out of context Mr. Breitbart has implied that since he couldn't find a real criticism of the current administration, he'd have to create one. It has lumped him in with MSNBC (when they showed a man holding a gun and implied the Tea Party movement is racist, cutting off the man's head since he was black) and others who distort the truth to fit their own political agenda.

Watching the full video, there are a lot of things conservatives can criticize. While Ms. Sherrod isn't racist, she does seem to have fairly left wing politics, dividing people into "haves" and "have nots". Mr. Breitbart could have written about this aspect of the speech, been perfectly accurate, but would not have stirred up near the controversy.

Even worse, while I don't agree with Ms. Sherrod's politics and she did push some government subsidized programs, the overall message of the speech was for people (blacks in this case as the audience was the NAACP) to be responsible and take responsibility for your life.

Mr. Breitbart might have done better praising Ms. Sherrod.,